Corporate raiders, vulture funds urge breakup of Samsung

If the press coming out of Korea is any indication, Samsung isn’t any happier with 2016 than the rest of us. The Galaxy Note 7 debacle blew up Samsung’s quarterly earnings, its washing machine recall
fueled negative consumer perceptions, the company’s Korean offices were
raided last week as part of an ongoing corruption investigation, and
now a vulture hedge fund with a major focus on distressed companies is
calling for the Korean giant to break itself apart in the name of
enhancing — you guessed it — “shareholder value.”

Elliott Management Corp proposes
that Samsung split itself into two companies, pay a $26 billion
dividend to stockholders, pledge to return 75% of free cash flow to
investors in the future, and appoint three new independent directors.
Samsung has already pledged to return 30-50% of free cash to investors
this year and has completed a share buyback worth $11.3 trillion won
($9.648 billion). That’s clearly not sufficient for Elliott, which is
run by billionaire Paul Singer. But while Elliott Management’s long-term
returns are excellent, its methods for securing those returns have come
under considerable fire over the years. Elliott Management is widely
viewed as a so-called “vulture” fund — a company that buys up distressed
assets of both nations and corporations for pennies on the dollar, then
spends years in litigation to recover the full value of the debt it
purchased. Singer has pursued cases against some of the world’s poorest
countries like the Congo, and forced Argentina into partial default by
refusing to accept the terms of a settlement that 93% of the country’s
other creditors had previously agreed to.

Activist investors like to claim that they
focus on improving yields, killing unprofitable products or business
segments, and encouraging companies to focus on their strengths, but
long-term investigations of the phenomena show decidedly mixed results. A
recent article at The Atlantic
noted that there were just 52 activist campaigns over a 20 month period
from 2005 – 2006, compared to 1,115 activist campaigns from 2010 –
2014. That’s a jump from an average of 2.6 campaigns per month to 23.22
over just four years. A new report entitled “The Wolf at the Door: The Impact of Hedge Fund Activism on Corporate Governance” explores this phenomena and its impact over the short-and-long terms. They write:

Recently, researchers have focused on the
targets of hedge fund activism to see whether the investments by these
targets in research and development increased or decreased in the
aftermath of a hedge fund engagement. In common, they have found a sharp
decline. A 2015 study used a sample of firms targeted in 2009 and found
that “surviving” firms (i.e., those not taken over) decreased their
investment in R&D (measured as a percentage of sales) by over 50%.

The chart below is taken from the paper, and
shows the sharp decline in R&D investment by activist targets
compared to average R&D spending in a random sample of companies not
targeted by activist campaigns.

The implications for Samsung, in this case, aren’t so different from the implications Qualcomm faced
when it was targeted by Jana Partners (Qualcomm ultimately defeated the
vultures who sought easier prey elsewhere). Slashing R&D and
splitting company assets might make a great payday for rich investors,
but it won’t serve Samsung or its customers. In fact, it virtually
guarantees Samsung’s own smartphone efforts will be superseded by other
companies and Chinese manufacturers, particularly if the Korean company
agrees to start returning the vast majority of its free cash directly to
investors. Samsung’s existing corporate board may be implicated in government scandals,
but slashing the firm’s R&D expenditures and committing to
aggressive self-enrichment schemes won’t benefit anyone but the handful
of ultra-rich investors at hedge funds like Elliott. Samsung has pledged
to respond to the activist investors by the end of the month but has
made no further comment.